An IPO Resurgence?

Private equity is helping to stoke the fire even as it offers a solid alternative to going public.Rob Garver, CFO MagazineFebruary 1, 2007

Since the bursting of the IPO bubble early in the decade, young companies have had to reconsider the viability of an initial public offering. Certainly, would-be investors have set the bar significantly higher in the past several years, making it clear that product-less, profit-less firms need not apply.

Instead of dying on the vine, some of these startups survived, even thrived, thanks to financing from private-equity investors, which are awash in cash. For these young companies, though, going public still may be in the future.

And in both the venture-capital and private-equity communities, there's a growing feeling that the future may be 2007, with a significant wave of pre-IPO firms now being nurtured by those private-equity backers.

A Late-stage Boost
David Spreng, managing general partner of Palo Alto, California-based Crescendo Ventures, is one who predicts a more active IPO market this year. "People are holding on to companies a lot longer than they used to, because the IPO market has not been there," he says. But that strategy is losing favor, he believes, driven in part by the companies themselves, which often chafe at having to wait to go public.

"Going public is the goal," according to Spreng. "When a CEO is rallying the troops, he's not planting his flag and telling everyone, 'Let's build this company so that we can sell it to a private-equity firm.'"

In last year's fourth quarter, public offerings picked up, if modestly, with 89 IPOs accounting for more than a third of the year's total of 228. That number still represented a slip from the 240 in 2005, although the amount raised by companies climbed to $46.1 billion from $36.9 billion. Those offering totals, however, were far short of the 1999 peak of nearly $70 billion (see "Primed for an Uptick?" at the end of this article).

Jeff Andrews, a partner in the technology group of Atlas Venture, predicts that 2007 "will be a tremendous year for IPOs, with the number of offerings up 50 percent," and featuring "higher-quality offerings than we've seen in the past."

Says Peter Y. Chung, managing partner of Boston-based private-equity and venture firm Summit Partners: "You are seeing a lot of capital available for late-stage pre-IPO financings. Historically, when you needed to raise $100 million of equity capital, the public-equity markets were the only option. Today you can raise $100 million of private-equity capital in a relatively straightforward manner." Private-equity players that pump money into late-stage start-ups eliminate some of the risk of investing in untested companies, but still stand to benefit from the upside of an eventual IPO.

Among likely high-tech IPOs, says Spreng, are broadband Internet provider Clearwire, of Kirkland, Washington, and Sunnyvale, California-based wireless security-systems company Aruba Networks. Clearwire, now rolling out its wireless broadband Internet and voiceover- Internet protocol service to cities across the country, raised more than $1 billion in August, mostly from venture-capital firms that included Intel Capital and Motorola Ventures. Aruba filed a registration statement for its offering in December.

A Textbook Case
Despite warnings that many IPOs are being driven overseas by Sarbanes-Oxley's internal-controls demands and more-stringent listing requirements among U.S. exchanges, some pre-IPO companies and private-equity backers seem relatively unconcerned — and committed to a trading future here.

Says senior managing director Robert L. Friedman, of The Blackstone Group: "Most of the companies that we take public in the United States were U.S. public companies themselves, or part of U.S. public companies, so they have a Sarbanes-Oxley regime in place already." (Blackstone took no portfolio firms through IPOs in the United States in 2006, notes Friedman, although it had an active domestic public-offering schedule in 2004 and 2005.)

One IPO company that lacked Sarbox experience found that to be no obstacle when it went public last year. "Regulatory hurdles like [Sarbox] were really not an important factor in our analysis," says Christopher R. Huber, CFO and vice president of operations for NightHawk Radiology Holdings Inc., based in Coeur d'Alene, Idaho. Sarbox "was just something we viewed as a best practice." Because NightHawk is a medical technology firm that provides teleradiology services, it is familiar with complex patient-privacy and information-technology security requirements.

The company, which raised more than $83 million in its February IPO, sold for $16 a share and traded around $25 at year-end. Its private-equity backers — including Summit Partners — were patient about timing the IPO, Huber says. The eventual decision to go public "was not purely based on cost-of-capital calculations," he adds. "We believed that public equity would also allow us the most flexibility in the capital markets to grow the company."

Its growth prospects meant that it would do well from a valuation standpoint, Huber says. But NightHawk also was concerned that more private funding might unnecessarily burden the company. "We didn't want to saddle the company with more debt," he says. "We wanted to have ultimate liquidity and availability of funds."

If the IPO market does come back this year, it won't be because venture firms lack a choice of exit strategies. Cash-rich private-equity firms are likely to remain an extremely viable alternative.

Blackstone, which in partnership with Bain Capital and Thomas H. Lee Partners owned Houghton Mifflin Co., was preparing for an early-2007 IPO for the textbook publisher when such a private suitor stepped in. The suitor, Riverdeep Holdings, of Dublin, Ireland, offered about $1.75 billion in cash and the assumption of about $1.61 billion in net debt. The IPO plans were quickly scuttled.

A private investor wishing to shed a portfolio asset has one overriding concern: getting the best price. "Whether a third-party sale or an IPO presents the best alternative will vary from deal to deal and from month to month," says Blackstone's Friedman. But "the IPO market has always been and always will be a significant exit strategy for us."